Don't Blindly Buy Dividend-Paying Stocks In 2012

Bond-fund manager Jeffrey Gundlach and other experts warn against investing in high-dividend-paying stocks while ignoring the risk of capital loss they pose. Photo: Reuters

Investors should be wary of stampeding into dividend-paying stocks in search of high yields in today's low-interest-rate environment, warns Jason Zweig, a personal-finance columnist for the Wall Street Journal.

He argues that the many investors who have already done so might not be paying enough attention to the risk of capital loss.

When considering yields alone, some stocks do appear more attractive than bonds.

Dividend stocks, however, don't offer the same principal protection as investment-grade and government bonds.

U.S. Treasurys, for example, are guaranteed to return the capital -- inflation is the only risk to investors -- if held to maturity. Investment-grade corporate bonds contain some risks to capital, but their loss probability has historically been much lower than that of stocks.

Over the past five years, the iShares Dow Jones Select Dividend ETF, which tracks its namesake Dow Jones index for U.S. stocks paying high dividends, declined nearly 25 percent.

During the same period, the iShares Barclays Aggregate Bond Fund, which tracks Barclays' U.S. investment-grade bond index, rose 10.21 percent.

With a one-year horizon, the iShares Dow Jones Select Dividend managed to rise 4.4 percent, but capital preservation is anything but certain when it comes to stocks, including ones that pay dividends.

Two heavyweight investors in the bond world have been shocked by the pretending-dividend-stocks-are-bonds mentality that has gripped investors in recent months.

Bob Rodriguez, CEO of First Pacific Advisors, which manages more than $19 billion, recalled his incredulity when a research adviser advocated buying utility stocks with 4 percent yields.

You would put your capital at risk in this kind of environment for a 4 percent dividend yield? Rodriguez remembers saying.

My focus is on principal protection. If you protect your client's capital, they live to fight another day, the bond manager explained.

Jeffrey Gundlach, CEO of DoubleLine Capital, which oversees a bond fund with over $20 billion in assets, said that although the idea of dumping bonds for divided stocks is superficially compelling, the truth is that stocks are much more volatile.

He said an investor shouldn't sell bonds to buy equity, ever, unless that person is buying into a bull market, which would lift stock prices.

Gundlach's advice reminds investors that for equity investments, both dividends and capital gains or losses matter; one can't embrace the fact some stocks pays high dividends while ignoring their risk to capital.

While dividend-oriented funds are a perfectly legitimate way to invest in stocks, you shouldn't mistake them for bonds, wrote the Journal's Zweig.